Macro Risk Premium and Intermediary Balance Sheet Quantities

The macro risk premium measures the threshold return for real activity that receives funding from savers. The balance sheet conditions of financial intermediaries provide a window on the macro risk premium. The tightness of intermediaries' balance sheet constraints determines their "risk appetite,"' which in turn, determines the set of real projects that receive funding, and hence determines the supply of credit. Monetary policy affects risk appetite by changing intermediaries' ability to leverage their capital. This paper estimates the time-varying risk appetite of financial intermediaries for the United States, Germany, United Kingdom, and Japan, and studies the joint dynamics of risk appetite with macroeconomic aggregates for the United States. The paper argues that risk appetite is an important indicator for monetary conditions. [JEL G2, E3, E5] IMF Economic Review (2010) 58, 179-207. doi:10.1057/imfer.2010.5; published online 3 August 2010